A merger with American Home Products (AHP) would create a powerhouse in the drugs industry. With annual turnover of more than pounds 16bn, including almost pounds 9bn of prescription drug sales, the combined group would become the biggest pharmaceuticals group in the world ahead of Novartis of Switzerland, Merck of the US and Glaxo Wellcome of the UK.
The City was betting last night that a merger was likely to be sealed within the next few weeks. "They have been talking to each other for some time and a deal looks near," said one source close to the talks.
Rumours of a bid on Wall Street have seen SmithKline's shares rise more than 80p since Friday but, after early gains again yesterday, they closed down 3p at 740p. But in New York, news of the talks sent the value of AHP soaring. By lunchtime on Wall Street, the shares were trading at $90, up almost $10 from the opening bell. The combined group would now be worth about pounds 77bn.
The merger talks were prompted by the huge cost savings that would result from a partnership. Analysts believe SmithKline and AHP could slash costs by pounds 1.5bn by the year 2000 by using each other sales and distribution networks.
The two groups could also increase expenditure earmarked for researching and developing drugs to more than pounds 1.5bn a year, one of the biggest budgets in the industry and well ahead of the likes of Glaxo Wellcome and Novartis.
One analyst said: "This will put the combined group in the top flight in terms of expenditure on new drugs which they were not really before. That is vital for their future."
Shares in drug companies around the world soared in anticipation of further consolidation in the industry. Glaxo Wellcome shares rose 30p to 1669p and the bid spotlight once again fell on Zeneca whose price jumped 60p to 2357p.
Robin Gilbert, drugs analyst at Panmure Gordon, said: "There has been a lapse in mergers ... but now it's party time again. Everyone will be looking at their options again."
A spate of corporate activity throughout the industry in the mid-1990s culminated in the formation of giant drugs group such as Glaxo Wellcome. However since Novartis came into being with the merger of Swiss groups Sandoz and Ciba-Geigy in 1996 there has been a dearth of big deals.
"As each merger takes place, it just ups the stakes for the next one," commented one US analyst. "A lot of people behind closed doors today will be figuring out what they will need to do if this goes through. There will be a lot of discussion of new mergers in that industry."
"This is an ongoing scenario," said Avend Desai, whose firm Orbimed Advisor, tracks the pharmaceutical industry worldwide. He pointed out that even as the world's largest player, a combined SmithKline and AHP would still have slightly less than 6 per cent of global market share. "That is a lot less than you see the leaders capturing in other industries".
Analysts agree, that with stock market prices of drug's groups escalating, agreed mergers are now deemed much more likely than hostile takeover bids.
If SmithKline and AHP merge, the new group is likely to be listed in the US. "With most of the business in North America it would make sense to relocate over there," said one industry source.
SmithKline makes some of the best known healthcare products in the world including Beecham's cold remedies, Panadol pain killers Aquafresh toothpaste and Nicorette patches for smokers determined to kick the habit. The group's best selling prescription drugs include Seroxat, the anti-depressant which is sold as Paxil in the US and is the group's answer to Prozac, and antibiotic Augmentin.
With a market value of around pounds 36bn, AHP is the third largest US pharmaceuticals group behind Merck and Bristol Myers Squibb. Worldwide, it is already sixth in the pharmaceutical rankings. It is also the supplier of some of the best-known - and most lucrative - products in the American market. These range from over-the-counter consumer medicines such as the pain- killer Advil and Preparation H (a haemorrhoids cream) to prescription drugs like the hormone replacement drug, Premarin.
City observers agreed that SmithKline's and AHP's products were a good fit. One industry analyst said: "There is a good overlap in therapeutic drugs. Both groups also have complementary vaccines business with AHP specialising in child products and SmithKline in adult vaccines."
However some analysts believe SmithKline's move was more to do with securing a larger product pipeline rather than simply cutting costs. One said: "We predict that SmithKline's earnings growth will begin to dip with Augmentin going off patent by 2003. This is all about giving Smithkline a wider range of products."
Any merger is thought unlikely to cause major competition issues although the new group may be forced to dispose of some products.
Industry sources are tipping Jan Leschly, the ambitious chief executive of SmithKline, for the top job in the combined group.
"Make no mistake - SmithKline would end up running the show. Leschly has orchestrated this deal. He wants nothing less than to lead the biggest drugs company in the world and is determined to do a deal," said an analyst.
SmithKline has slipped down the pharmaceutical industry's pecking order in recent years and is currently only the ninth largest drugs group in the world and second biggest in the UK behind Glaxo Wellcome.
A merger would solve the management succession problems at AHP. Chairman John Stafford has been seriously ill and Fred Hassan, the director who was favourite to replace him, left the group last year to become chief executive at rival Pharmacia & Upjohn.
However, there are several clouds on AHP's horizon that may be weakening its hand in the talks with SmithKline. Among these is the threat of competition for the first time to its highly lucrative Premarin drug - a name derived from its primary ingredient, pregnant mare's urine - which it first patented in 1942.
Premarin is used by some 8 million American women, mostly for post-menopausal hormone replacement and to combat osteoporosis. On its own, this drug has earned AHP roughly $1bn a year. However, new drugs of the same type may soon be on the market from Merck
Perhaps worse for AHP, however, is the gathering onslaught of class-action lawsuits filed against it and some of its executives stemming from its decision, under intense government pressure, to withdraw from sale two leading dieting drugs, Redux and Pondimim.
The two drugs, manufactured by Wyeth-Ayerst, were commonly used in the now discredited diet cocktail known as Fen-Phen. They were withdrawn after research demonstrated that they could cause potentially fatal complications including an unusual hardening of the heart valves and pulmonary hypertension.
Among the lawsuits is one filed by some of AHP's own shareholders who have claimed that executives at the company knew of the difficulties months before they were made public and that they sold some of their own shares in the company in anticipation of the storm that was about to break.
This month also saw the start of a first trial considering another lawsuit over Norplant, a contraceptive device that looks like matchsticks that are placed under a woman's skin in the arm. Plaintiffs argue that AHP concealed the extent of negative side-effects of the drug, including personality changes among those who take Norplant.
Even if a deal with AHP fails to materialise, few experts believe that SmithKline will remain independent for long. "If Smithkline don't do a deal with AHP then they will probably do it with somebody else," said an analyst.
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